Surprise Game-Changer At Coca-Cola: Alcoholic Coke

Gene Marcial
, ContributorI have an insider's take on Wall StreetOpinions expressed by Forbes Contributors are their own.

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Coca-Cola, one of the most, if not the most universally known U.S. product brand worldwide, will remain a colossus in soft drinks, but it will also leap into a totally different space: Alcoholic Coke.

That, indeed, would be a game-changing shock: The world’s largest soft-drink company has introduced an alcoholic beverage—in Japan, initially.

Yes, an alcoholic Coke! But, as large as a shocker that may be, alcoholic Coke will only add more positive twists to the famous Coke, whose globally popular soft-drink has triumphed with universal acclaim. Yes, alcohol in Coke is a huge momentous surprise and should deliver additional exciting heft to the Coca-Cola brand. And that means a new source of top-line growth and additional boost to Coke’s bottom line.

As one large Coca-Cola institutional stakeholder pointed out, Coke needs such a new marketing mojo, to enhance and expand its global franchise.

So, the world’s largest soft-drink producer will launch the alcoholic Coke in Japan—a sparkling alcoholic drink, the first in the company’s history. Coke will use a popular type of Japanese "alcopop” called Chu–Hi, mixed with flavored carbonated water, according to industry analysts.

“While noteworthy given that it marks KO's first foray into the alcoholic space, we view it as more evolutionary than revolutionary, consistent with Coke's openness to emerging categories outside of its core,” said Kevin Grandy, equity analyst at investment firm Jefferies. So the question among investors is how the alcoholic product will change or affect Coke’s results over the long-term.

Grandy sees the news as “supportive of the positive view we have on Coke," in part because he expects only “limited impact on KO/Euro brewers/bottlers for now.” He sees the potential impact will be limited to Japan initially. The Wall Street Journal was the first to report on Coke’s coming alcoholic product.

“We maintain a positive bias on CEO James Quincey's vision to make KO a more nimble, leaner and consmuer-centric company, focused on accelerating growth,” said Grandy in a recent report on Coca-Cola. “The company’s global leadership is talented and its shared vision for KO’s path forward apparent,” he added. There’s s lot to like here, noted Grandy, and “Quincey is clearly the right leader at the right time for KO.” The stock’s valuation looks full, however, trading at 25 times EV/ULFCF (10 times premium to peers), noted Grandy, who rates the stock as a hold.

But Joseph Agnese, equity analyst at CFRA, reiterated his recommendation of a “strong buy,” noting that he expects Coca-Cola to continue making progress on the enfranchising of its U.S. bottling system, after completing U.S. re-franchising in 2017.

“Although completion of these transactions will reduce sales in 2018, we expect these moves to improve operating margins in the longer term as the bottling business has significantly lower operating margins than the concentrate business,” Agnese said. He sees Coca-Cola having “attractive relative international footprint, particularly in faster-growing emerging markets, and the capability to generate strong cash flow, which we think will be returned to shareholders through dividends and stock repurchases." Currently, the stock provides a dividend yield of 3.57%.

The company’s profit margins have been solid. Agnese said he expects the EBITDA margin to widen to 37.7% in 2018, up from 30.9% in 2017, "as price increases, productivity improvements, a more favorable commodity cost environment, a favorable shift in business mix due to bottling divestitures, and cost-cutting offset unfavorable impact from geographical mix and increased marketing spending.”

The company’s bottom line has definitely improved, as Agnese sees earnings jumping from 27 cents a share in 2017, way up to an estimated $2.08 a share in 2018 and $2.20 in 2019. Agnese has a 12-month price target for the stock of $51 a share. It's currently trading at about $44 a share.

Bonnie Herzog, equity analyst at Wells Fargo Securities, came away from Coca-Cola’s recent meeting with analysts “with increased confidence that KO is well-positioned to hit their organic sales growth target of 4 percent in 2018.” Rating the stock as “outperform,” Herzog noted that the company has “strong underlying industry fundamentals, improving emerging market macros (particularly in Brazil, which was a drag on KO’s top-line in 2017), “premiumization” driven by a combination of smaller pack sizes and premium products, and "easing re-franchising headwinds.”

“We expect Coca-Cola to continue to scale its global leadership position with innovation that leverages strong existing brands, creates a ‘premium experiences’ and pursue 'on-trend nutrition, all of which should help derive improving margins,” said Herzog. The analyst has a price target of $52 a share on Coca-Cola’s stock.

Herzog added that “CEO Quincey’s efforts to transform Coca-Cola into a total beverage company and leverage improved marketing, innovation and execution to drive improved top-ine growth, remain solidly on track.”

Coca-Cola has outperformed its international peers on its top-line, "with its 6 percent organic delivery this past quarter, which not only outperformed but widened the gap versus global CPG peers over the past three quarters,” noted Nik Modi, equity analyst st RBC Capital Markets. “KO had one of its strongest quarters in years,” with the company’s strategies — "on franchising, price/mix leverage, diversification, cost discipline and improved marketing efforts — all working,” noted Modi.

The analyst, who rates Coca-cola as “outperform,” has a price target of $56 for the stock. He has raised his earnings estimates for 2018 to $2.10 a share from $1.97, mainly due to the expectation of lower effective tax rate (21% vs. prior estimate of 26%) and "continued strong fundamentals.”

So from Coca-Cola’s formidable leadership in the soft-drinks industry, many investors already assume that the company’s initial foray into alcoholic beverages should turn out to be a success, as well.